The Great Economists Page 5
The Industrial Revolution caused Britain to become the richest country in Europe, too, but agricultural output grew less rapidly than the expanding population. As a result, there was heavy reliance on imports of food and raw materials. Those two categories made up almost all imports at a time when Britain was the largest trader in the world owing to its colonial empire.
Still, contrary to popular perception, early-nineteenth-century manufacturing remained dwarfed by the retail trade and crafts. The most popular occupations were those of baker, blacksmith, butcher, bricklayer, carpenter, mason, publican, shoemaker, tailor and, of course, shopkeeper. And, despite the country’s prosperity, real wage growth, that is wage rises minus inflation, failed to keep pace with production per head from 1760–1850. Consumption per person was even stagnant between 1780 and 1820.2
But the fruits of the Industrial Revolution were accruing to some. Landlords were doing well and capital owners too, since they were investing in factories and machines. As a result, inequality increased. In 1810 the top 10 per cent of individuals owned around 85 per cent of the total wealth. This percentage rose to over 90 per cent by 1900. The top 1 per cent of households owned more than 50 per cent of the nation’s wealth at the beginning of the nineteenth century, a figure that rose to nearly 70 per cent by the start of the twentieth century.3 With his fortune of more than £600,000, Ricardo fell short of being counted as one of Britain’s 179 millionaires, but was one of the 338 who had at least half a million pounds.
In Ricardo’s day, more than one in two of the very wealthy men in Britain were landowners, a statistic all the more surprising because the Industrial Revolution had created fortunes for industrialists. Apart from land, the wealthy were in commerce and finance, for example bankers, brokers, merchants and ship owners. With his origins in the City of London, the financial centre of the world, and his huge country estates, Ricardo had a foot in both camps of the elite of his time. The bottom tier of society was the newly created class of wage earners. By the middle of the nineteenth century, the share of workers earning industrial wages had increased to around 80 per cent, more than doubling in a century.4 Thus, a simplified three-tiered social structure formed the basis of Ricardo’s economic models. For instance, Principles sets out a three-class capitalist economy in which the accumulation of capital depends on the profits made by the capitalists running Britain’s industries.
Also, Ricardo believed Britain’s economic prospects would be determined by the struggle between protectionist landlords and the rest of society. He observed: ‘the interest of the landlord is always opposed to the interest of every other class in the community.’5 Ricardo saw landlords pushing for protectionist laws like the Corn Laws that would help them but harm the economy.
Another important aspect of Ricardo’s ideas was that he followed Jeremy Bentham’s definition of utility for a society, which advocated the greatest happiness for the greatest number. Thus, he established a utilitarian basis for his argument in favour of free trade. As it was the most productive economic system, trade had the potential to fulfil Bentham’s criterion.6 In Ricardo’s model of trade, because the economy as a whole benefits from international trade, the distributional consequences matter less.
His model of trade reflected his belief in the scientific nature of political economy. This was not a widely accepted view. When he entered Parliament, Ricardo was treated with great respect, but not after he proposed a tax on capital to pay off the national debt, something regarded as a ‘wild sort of notion’ even by his friends.7 Practically every eighteenth-century economist thought the national debt was a bad idea and that some drastic measures were needed to pay it off. Ricardo’s misfortune was that he was perhaps the most cogent.
Attitudes towards him changed after that. He came to be looked upon as a theorist, an epithet not intended as a compliment. Ricardo defended economic theory against those who relied on facts alone. Indeed, according to the economic historian Mark Blaug, ‘the divorce between abstract theory and practical work was never more complete than in the heyday of Ricardian economics’.8 That led to criticism of Ricardo by leading figures such as Walter Bagehot, editor of The Economist: ‘To the end of his days, indeed, he never comprehended what he was doing. He dealt with abstractions without knowing that they were such; he thoroughly believed that he was dealing with real things.’9
The Austrian economist Joseph Schumpeter even coined the term ‘Ricardian Vice’, which highlighted Ricardo’s alleged habit of making ‘heroic assumptions’.10 Schumpeter criticized Ricardo for introducing assumptions into a simplified representation of the economy in order to produce the desired results.11
Nevertheless, Ricardo’s impact on economics is lasting, and not only in the area of international trade. Ricardo developed the theory of ‘economic rent’. As more land is cultivated, farmers plough less productive land. But a bushel of corn sells for the same price, which does not depend on the productivity of the land. So, the farmers do not earn more if they have to work harder to produce a bushel of corn. Thus, only the landowners gain from higher land prices owing to scarcity. They have not exerted any effort to earn the higher rents charged to farmers. This is in line with his view of landowners, of course, that they were rent-seekers. Rent-seeking is one of the most widely used economic concepts today, for example, to explain why political corruption persists in some oil-rich countries, since there is an incentive to seek to hoard the ‘rents’ from selling oil and not share it with the country as a whole.
Ricardo’s model of international trade
David Ricardo’s approach to international trade was rooted in his background, while his interest in economics was stimulated by The Wealth of Nations, so it is unsurprising that he further developed Adam Smith’s approach.
Smith wrote: ‘If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them …’12 Accordingly, Ricardo focused on what generated efficiency. His focus wasn’t on achieving a trade surplus or avoiding a deficit, but on increasing trade which made a nation more productive. Ricardo and Smith both argued against the eighteenth-century mercantilist doctrine that a favourable balance of trade and money, including amassing gold and silver, led to economic growth. They exposed the fallacy that the way to grow was to aim for a trade surplus, instead of working efficiently and producing goods for the economy.
Ricardo’s writings on trade were interlinked with his thoughts on the three great contemporary issues of his day: currency stability, national debt and protection of agriculture. International trade theory concerns more than simply looking at how the export or import sector is performing. Instead, he preferred to think of trade as domestic firms and their consumers selling and consuming across national borders. Hence his view that trade analysis ought to be linked to domestic economic policies. The event that shaped Ricardo’s views was the parliamentary debate on the protectionist Corn Laws in June 1813, under which tariffs and restrictions were imposed on imported grain in order to keep domestic prices high. (Despite the name, ‘corn’ then referred to all farmed grains and not just corn.)
In Ricardo’s theory, ‘general profits must fall, unless there be improvements in agriculture, or corn can be imported at a cheaper price’.13 Ricardo’s model was based on what he had observed. The law of diminishing returns means there is a natural tendency for profit per marginal unit produced to decline, because the unit price will fall as supply increases. So, for Britain, the ability to trade abroad freely, especially in food, was important for economic growth. Ricardo saw a conflict between landowners, who were the proponents of the protectionist Corn Laws, and the rest: ‘[The landowner’s] situation is never so prosperous, as when food is scarce and dear; whereas, all other persons are greatly benefited by procuring food cheap.’14
Ricardo and the Corn Laws
By the time of the Corn Laws there had already been a long history of government intervention in Britain. The state was heavily involved in the regulation an
d taxation of trade throughout the eighteenth and early nineteenth centuries. During the Industrial Revolution, Britain’s trade policies were essentially mercantilist. The Corn Laws imposed significant tariffs on agricultural goods, while the Navigation Acts protected shipping by requiring all English trade to use English ships.
Since the reign of William and Mary, the British government had offered financial support to its prime constituency, namely landowners. British cereals were among the most expensive in Europe, yet until 1760 Britain was able to be a major grain exporter owing to government subsidies.15 In the late eighteenth century there was a brief period of trade liberalization between Britain and France, but this ended with the Napoleonic Wars. This was followed by the reinstatement of the Corn Laws in 1815. Trade was not very free for much of the first half of the nineteenth century.
Adam Smith had excluded food in his defence of free trade. Ricardo, by contrast, was not too concerned about depending on foreign countries for food, noting that even during the Napoleonic Wars, France had continued to export corn to Britain after lobbying by French exporters. Ricardo also rejected the claim that free trade in corn would increase the volatility of food prices. He pointed to Holland, which depended almost wholly on foreign supply, and yet did not experience food price instability.16
Ricardo believed that trade brought about specialization, which would raise the efficiency of production. Free trade in corn would, in Ricardo’s view, have ‘a decided tendency to raise the real wages of labour … all capitalists whatever, whether they be farmers, manufacturers, or merchants, will have a great augmentation of profits’.17 Although some might lose out,18 the economic gains to the country as a whole were of far greater importance, or, as he put it: ‘I shall greatly regret that considerations for any particular class, are allowed to check the progress of the wealth and population of the country.’19
Ricardo’s campaign against trade restrictions played an important part in the eventual repeal of the Corn Laws in 1846, twenty-three years after his death. In addition, his arguments against the Bank of England issuing too much money led to the Bank Charter Act of 1844, also called the Peel Banking Act, which established a strict anti-inflationary monetary standard for the central bank.
After these two historic policy changes, Britain rapidly became the ‘workshop of the world’, exporting manufactured goods as befitting the world’s first industrial nation. Great Britain became one of the most open major economies in the world, dominating international trade until the rise of the United States.
A tale of two trade deficits
Although Britain remains one of the most globally oriented economies, it has, since its nineteenth-century heyday, also acquired a large trade deficit. The broader concept was discussed in the previous chapter. Here, we look at the issue in depth.
Since the 2008 crisis, Britain’s external deficit had hit a record high. The UK’s current account deficit at 5.2 per cent of GDP in 2015 was the largest since at least 1948. The current account is a broad measure that includes traded goods and services as well as monies that flow into and out of the country. The deficit thus includes the cross-border movement of monies by large multinational companies, which isn’t a source of concern. But the underlying structural trade deficit in goods and services, which excludes money flows, is 2 per cent or so of GDP. That is what warrants discussion. That’s why we need to ask whether Britain should be concerned that it consistently buys more from abroad than it sells. Can the UK afford to keep doing this? Is that sizeable trade gap even measured accurately? That second question arises because most of the economy – more than three-quarters of national output – is comprised of services such as education and finance.
The two questions are related. If the biggest part of the British economy isn’t accurately measured, then it follows that exports of services are also likely to be imprecisely accounted for. Therefore, it is possible that Britain’s trade deficit in goods and services is not as large as it appears in the official statistics, which might make it somewhat less of a worry.
And the UK sells a lot of services overseas. In 2015, the export of services reached a record surplus of over 5 per cent of GDP. That certainly goes against the picture of a worsening overall trade deficit. Trailing only the United States, Britain is the second largest exporter of services in the world. By contrast, trade in goods recorded a record deficit of over 7 per cent of GDP, resulting in a net 2 per cent deficit.
Could the surplus in the services sector eventually push the trade deficit towards balance? That’s not entirely unthinkable. Harvard economist Ricardo Hausmann and his co-author Federico Sturzenegger estimate that the large US trade deficit would actually be a surplus if assets that generate revenue but cannot be seen were properly accounted.20 The same might well be true of the UK.
So, just how poorly is the dominant but not visible part of the UK economy, services, measured? Since the exports of services are called the invisible balance, it certainly increases the likelihood of mismeasurement. There are also ‘manu-services’, such as the output of firms in the engineering and software sectors that produce both goods and services, and these are easily misclassified by statisticians. If services were measured more accurately, perhaps we could worry a bit less about the trade deficit.
There is also huge scope for growth in the export of services. Unlike in manufacturing, post-war global trade liberalization has not progressed much in services. Nearly all of the global trade in goods is covered by a wide-reaching multilateral agreement overseen by the World Trade Organization (WTO). By contrast, services haven’t seen the same degree of opening up of markets. Service-sector liberalization would help ameliorate Britain’s and America’s trade deficits since they are among the largest services economies. At present, Britain’s service exporters face more trade barriers than their counterparts in manufacturing or resources, but if, for example, the Trade in Services Agreement (TiSA) currently being negotiated by some WTO members comes to fruition, then it would open up world markets for trade in services in a similar manner as manufactured goods and services would face far fewer obstacles to trade, which should reduce the UK’s deficit.
Services trade is changing even without a new multilateral trade deal. As already noted, emerging markets are increasingly demanding the types of highly skilled professional services that Britain specializes in such as education and law. It may not be enough to overcome the traded goods deficit, but the demand for services is growing.
As in Britain, the majority of the US economy is made up of services like retail, creative industries and banking. Deindustrialization for the past half century has been associated with a loss of well-paid manual jobs and stagnant wages. It’s partly related to globalization and the rise of offshoring, the phenomenon whereby nations with cheap labour costs have taken over the production of lower-end manufactured goods.
As in Britain, too, the trade deficit is a long-standing issue for America but there are signs of change. In the past decade, some factories have been returning to US shores. Is American manufacturing undergoing a renaissance? The ‘advanced industries’ are leading the US recovery, according to the Washington DC think tank, the Brookings Institution.21 These are industries which invest a great deal in R&D and are more tech-focused. The revival of ‘Made in America’ was happening before President Donald Trump’s ‘America First’ policy.
Rather unexpectedly, Tennessee is one of the states leading the revival of manufacturing. The largest car factory in North America, owned by Japanese firm Nissan, is located in the home of country music rather than Michigan. Nissan decided to site more of its car production in Tennessee in recent years, exporting to over sixty countries around the world, but the production lines of today are nothing that Henry Ford would recognize. Robotic arms assemble the cars while other robots drive supplies around a factory that is an astounding 5.3 million square feet. So, even as manufacturing expands, fewer workers are needed than before.
It’s not only forei
gn companies that are coming to America. After decades during which production had been leaving the United States, American companies like Stanley Black & Decker, which were manufacturing in countries like China, have been returning. Stanley Black & Decker recently produced their first power tool in the US in over twenty-five years. The catalyst is an almost perfect storm of factors that have boosted American manufacturing. The extraction of oil from the country’s shale has lowered energy costs and made the US competitive again. Rising wages in emerging markets such as China is another reason. Stanley Black & Decker calculates that it costs about the same to produce in America as it does in China, once logistics and transport costs are taken into account. Plus, the US has maintained its position as the technology leader, so productivity is high.
As for Tennessee, there is a long history of innovation in the state. Eastern Tennessee is where the atomic bomb was developed. Federal funding now fosters advanced industries, so those with a high proportion of R&D spending, and STEM (science, technology, engineering and mathematics) workers. For instance, the funding for Oak Ridge National Laboratory supports the development of 3D printing (also known as ‘additive manufacturing’). This automated process requires only human programming for just one robotic arm to produce the husk of a car, secreting layer upon layer of plastic. The associated manufacturers who supply the parts and distribute the products also benefit. The company working with Oak Ridge to create the plastics that make the car body strong enough to withstand road stress is a reminder that manufacturing is still based in factories, as is clear from the smell of melting plastic and the loud whirling of machines that accompany this high-tech process.